Markets braced for Italy and Saudi tensions

The spotlight will continue to fall on Italy as well as global tensions over the alleged killing in Istanbul of Saudi journalist Jamal Khashoggi, analysts said.

Rome’s new government is keeping up the pressure by not blinking in its spat with the European Commission over its budget spending plans, which Brussels has warned break the EU’s spending rules.

Nonetheless, an EU official said it won’t interfere with Italy’s economic policies, helping to reverse a slide in Italian markets, just as investor worries over EU opposition to the country’s aggressive budget were coming to a head.

Fiona Cincotta, senior market analyst at City Index, said that the spotlight will continue from Monday with the country suffering a possible downgrade of its huge debt pile.

“Italian banks have tumbled across the week and are trading at their lowest level in 18 months as fears over the country’s debt and its financial sector refuse to go away. Italian banks such as UBI Banca, Banco BPM, and UniCredit declined between 3.5% to 5.5% as they are directly exposed to sovereign debt through their holdings of Italian bonds,” Ms Cincotta said.

“With concerns of another debt crisis rising and S&P Global widely expected to downgrade Italy’s credit rating, the Italian government could find themselves backed into a corner by market forces rather than succumbing to the European Commission,” she added.

With the value of Italian bonds falling in recent weeks and the yield on its 10-year bond trading at 3.6%, Italian bank stocks had been hit because they hold Italian government debt on their books. For comparison, the yield on the Irish 10-year bond has crept higher but trades at just above 1%.

“We advise not to hold any bank for the coming days-weeks,” Valerie Gastaldy, technical strategist at Day By Day, said. “Wait for the market to show a convincing bottom, and then for the sector to stabilise before buying,” Ms Gastaldy said.

Global investors will probably need more good news to spur a return to Europe. Europe equity funds posted their biggest outflows in 27 weeks, according to Bank of America Merrill Lynch. This brings outflows so far this year to €43.5bn. Capital Economics said the commission’s letter to Italy “was probably more strongly worded than expected”.

“The commission has called for a response from Italy by midday on Monday, but there would be no direct repercussions if that deadline were missed. Either way, the commission will give its final ‘opinion’ on the draft budget by 29 October, which is likely to request that Italy re-writes the document,” the economists said.

Capital Economics said that “the least likely outcome” was for the collapse in the Italian government over the spat.

Meanwhile, oil prices headed for a weekly loss as plentiful supplies helped offset worries that tensions between Saudi Arabia and the US over the disappearance and alleged killing of Saudi journalist Jamal Khashoggi could lead to the use of crude as a political weapon.

Brent traded at $80.09 a barrel in London, up 80 cents. The contract was down 0.4% for the week.

Saudi Arabia had issued a veiled threat about using its position as a major crude supplier if the kingdom is punished for the disappearance of Mr Khashoggi.